Most businesses start their lives in rented quarters. Sometimes, they remain that way throughout their lives, but many companies, especially those not dependent on retail traffic, decide that it is far better to own than to rent. There can be many reasons for this, but they generally boil down to economics. Let’s take a look at a few considerations in making the decision to buy or rent your place of business.

The Rewards of Ownership

Ownership has its rewards, especially in a rising market. Assuming the building you purchase is not a single use type building, as each day passes, your investment as an owner will increase. Even if the market is flat, with each principal payment, your ownership of a tangible asset increases. Neither of these is true of renting. There is no potential return on your investment when you lease property and you do not build up any ownership equity when you pay the monthly rent.

Disadvantages of Ownership

Everything has its rewards and its disadvantages. In good times, buildings can be good investments, but times are not always good. Market fluctuations can cost a building owner a great deal in investment value. What’s more, if the building is single use, like medical and similar specialty buildings, when it comes time to dispose of the building, the market could be very limited.

Just the simple costs of ownership can be a disadvantage to owning your own building. Major repairs can be very expensive. While some leases basically require the lessee to cover normal building expenses, most do not require major repairs or replacements like roof repairs, replacements and other major system repairs.

Tax Considerations

If you have been around business for very long, you may be thinking that there are tax advantages to leasing real estate. This is true, but you pay for those advantages. In setting rent, a building owner must consider all of the expenses of operating the building, including building depreciation. Since the owner cannot bank on an increase in the building’s value, rent must be set to cover all of these costs and provide a reasonable return on investment. This means the rent must be higher than what the building cost would be if you owned it. The offset to this higher cost is, of course, immediate deductibility of your monthly payments instead of capitalizing and depreciating the building over a long period of time, generally 39 years.

Entity Considerations

Tax laws affecting real estate ownership can be very tricky, but for the most part, they penalize ownership by corporations, but reward individual ownership. This is because regular corporations (i.e. those that are taxed on their income at a corporate level) have few ways to get profits out to their owners without incurring double taxation (i.e. tax at both the individual and corporate level). Accordingly, if a corporation owns real estate that can be sold at a gain, the gain will first be taxed at the corporation’s marginal rate. If you, as shareholder, then want to get the money out, then you must do so through a dividend (generally taxable at 15%) or by increasing your salary, which increases payroll taxes.

On the other hand, individuals pay tax once. Any gain on a property will be taxed at a 15%-25% tax rate, but only once. The problem with individual ownership is it places all of the owner’s assets at risk should there be a liability suit asserted against the building owner. For this reason, the most popular entity in which to hold real estate today is the limited liability company (LLC). The LLC basically affords the owner of real estate the asset protection afforded a corporation while allowing the owner to treat the company like a partnership for tax purposes. Since partnership income is taxed on the partner’s tax return, any gain on a property sale is taxed once.

Another advantage of owning property as either an individual or in an LLC is that the company can pay a reasonable rent (one that exceeds the owner’s costs) and get income out to the owner without causing self-employment or payroll taxes.

Conclusions

Many businesses these days are finding it more economical to own rather than lease their business premises. The reasons for ownership and the manner in which ownership is held are critical decisions in maximizing value to you as the business owner. Before you take the plunge into real estate ownership for your business property, give us a call. Let’s take a look at what is best for you.

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.